Bumpy ride predicted for markets in 2016

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The Federal Reserve’s widely-expected US interest rate hike this week is likely to be followed by volatility across global financial markets in the first half of 2016, an investment analyst at independent financial advisor deVere Group warns.

Tom Elliott, the group’s senior international investment strategist, cites the Fed’s highly-anticipated announcement and the recent acrimonious OPEC meeting which triggered a collapse in the oil price as presaging a period of volatility in financial markets as stock and bond markets learn how aggressive the Fed is likely to be in its monetary tightening.

“There are, however, a few safe bets,” he adds. “The European Central Bank (ECB) last week revealed itself to be less willing to expand its quantitative easing (QE) programme than had been supposed, which somewhat undermines the strong dollar/ weak euro bet that underlies much stock and bond market asset allocation.

“How will higher US rates affect the US economy? In short, we don’t know. The hawks at the Fed want tighter monetary policy now, to prevent wage inflation taking off. They cite reasonably stable – though hardly robust – economic growth and a shrinking unemployment rate as evidence that the economy needs to have more normal interest rates.

“The doves, mindful of the low labour participation rate that helps keep wage growth low, fret that raising rates too fast, too soon, will hurt an economy that is weaker than headline gross domestic product (GDP) data suggests.

“The doves, mindful of the low labour participation rate that helps keep wage growth low, fret that raising rates too fast, too soon, will hurt an economy that is weaker than headline gross domestic product (GDP) data suggests.

“If the hawks are right, US and global developed stock markets should be able to see off a few 25 basis point (bp) rate hikes in 2016. Treasuries and other core global bond markets will weaken.

“If the doves prove correct, raising interest rates now may lead to a sell-off on US and global developed stock markets, as it becomes apparent that the Fed has committed a policy error. Treasuries and other core bond markets will recover quickly, as investors sell risk assets and we once again consider the prospect of recession and deflation in the US.

“Higher US borrowing rates will also be bad news for indebted emerging market economies. Not only will interest rates rise, but repayment costs in local currency terms will also go up as the dollar strengthens. Therefore we may well see further stock market underperformance from emerging market economies, particularly from those that rely on commodity exports for much of their foreign earnings.”

Turning to the recent OPEC meeting, Elliott comments: “The disarray at the summit highlights the likelihood of the ‘lower for longer’ theme that haunts energy and mining prices, and which is a disrupting force in the global economy and financial markets.”

As a result, he believes that many investors are likely to favour Eurozone and Japanese equities over those of the US and emerging markets, on the grounds that structural economic reforms in both will deliver long-term domestic demand growth even if the benefits of QE are more questionable. Further ahead, Elliott suggests that the financial markets may be calmer later in 2016, “by which time, history suggests, markets may have regained some stability.”

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